Skip to Content

Hypocritical protests at depositor bail-in proposal

Am I the only person to feel that the howls of moral outrage, protests and scathing editorials that greeted the first plan to “solve” the Cyprus banking crisis were somewhat overdone?. I myself joined in the criticism of the proposal to tax all deposits, and recommended the example of Iceland – while pointing out that Cyprus is indeed a special case. Of course, it was no way to increase market discipline on banks if the scheme was to operate so as to protect shareholders, or indiscrimately to tax deposits at sound banks as well as insolvent ones; I did not see the proposal spelt out in detail. The latest plan for Cyprus bails in only large depositors (Iceland bailed in foreign depositors), as well of course as shareholders and bondholders and has been widely praised.

But we missed pointing out the elephant in the room.

Why did not editorialists protest in equally “outraged” moral terms at the fact that the inital plan to bail in all depositors – large and small – would merely have done openly what all governments do by stealth through the inflation tax?

But far from recognising the moral equivalence of these two forms of theft, the same economists who one moment are up in arms protecting “small depositors” are the next moment telling the new governor of the Bank of Japan that he must accelerate the inflation rate there to 2% as soon as possible, are urging Mark Carney to follow a much more “active” (looser) monetary policy in the UK, are pressing the ECB to open the monetary floodgates to further financing for debtor countries in the euro and urging the Fed to adopt nominal GDP targeting, here a euphemism for higher inflation targets?


Since the start of the millennium the cost of living has risen by 36% in the US and 47% in the UK (all-urban CPI index in US and the all items RPI index in the UK). The purchasing power of money held at banks has thus fallen steeply. Through the instruments of “independent” central banks, governments have thus creamed off a significant proportion of the real value of citizens’ holdings of cash and non-interest bearing current accounts. Yet few economists protest against this legalised filching (ignoring here the small sums of interest that some depositors will have received on some accounts from some banks during the period). Who is deploring the immorality implied in the “fiscal drag” that finance ministers such as George Osborne are relying on to help keep bulging budget deficits under some sort of control? But it is inflation dragging more and more taxpayers into higher tax brackets – and boosting receipts from capital gains and other taxes as asset prices rise – that has been “the Chancellor’s friend” through this crisis – and for many years before. And the inflation tax usually hits poorer people most.


By such “legal” means governments through the world have quietly over the years taken a greater proportion of the savings of their citizens than the Cypriots were planning to do more openly.


Actually, to go further, it turns out that deposit insurance is a confidence trick. By promising to exclude bank deposits by individuals below a threshold safe from default, governments fatten up banks in order the better to pick their customers’ pockets. They also provide bank managers with a guaranteed and reliable source of funding with which to enrich themselves through gambling. Inflation targeting has in reality formed another part of the trick. It offers reassurance. It is supported by economists and expert commentators. But bank deposit holders still lose out. For example, since the Bank of England was made operationally independent with a mandate set by the government to pursue price stability (as defined by the government) in 1997 UK retail prices have risen by more than 50%. For many individuals the cost of living has risen much more steeply.


A small step out of the money trap?

But there is one positive aspect of the Cyprus affair. Details have not yet been published, but it appears that large depositors will be required to exchange a proportion of their deposits for bank stock. Although a hamfisted way of introducing equity risk to the bank deposit universe, strategically this is the right way to go – and, as I argue in chapters 14 and 15, the way that banking should develop in future. Bank depositors should understand clearly how risky banking is, by being required to hold deposits in the form of shares. They should be able to choose between levels of risk they are prepared to assume – with no creditors being excused entirely from bearing a small risk.


At the moment the regulatory establishment still cling onto the belief that forcing banks to hold enough capital will suffice (as urged in the much-praised new book “The Bankers’ New Clothes” by Anat Admati and Martin Hellwig – review here )


I don’t believe it will – so long as limited liability exists, bank management and shareholders will still have the incentive to gamble. Higher capital would merely make loans more expensive and harder to get.

I am fully aware that such proposals – of converting banks in the long run to mutual funds – are still far too radical; but just look at how the discussion has moved in the past few years – who would have thought that proposals for a 30% capital minimum standard would ever get a hearing?